McGILL LAW JOURNAL
Vol 22
Montreal
1976
No. 2
Ratification and the Derivative Action Under
the Ontario Business Corporations Act
F. H. Buckley*
Few doctrines of company law have been quite-so persistent as
the rule in Foss v. Harbottle,' under which an individual shareholder
may not complain of those breaches of duty owed to his company
which are ratifiable by a majority of shareholders On its authority,
directors have been able to escape the consequences of their wrongs
for more than a hundred and thirty years. 3 Recently, however, section
99 of the Ontario Business Corporation Act 4 has given dissenting
B.A., LL.B. (McGill); LL.M. (Harv.). This article is based upon a thesis
submitted for the degree of Master of Laws at Harvard Law School.
1 (1843) 2 Hare 461, 67 E.R. 189.
2 The leading article on the rule remains that of K. W. Wedderburn, Shareholders' Rights and the Rule in Foss v. Harbottle (1957) CambridgeL.I. 194,
(1958) CambridgeL.J. 93. For more recent Canadian studies of the rule, see
S. M. Beck, "An Analysis of Foss v. Harbottle" in . S.Ziegel (ed.), Studies
in Canadian Company Law (1967), vol.1, 545; The Saga of Peso Silver Mines:
Corporate Opportunity Reconsidered (1971) 49 Can.Bar Rev. 80, 114 et seq.,
reprinted with changes in I. S. Ziegel (ed.), Studies in Canadian Company Law
(1973), vol.2, 193, 216; The Shareholders' Derivative Action (1974) 52 Can.Bar
Rev. 159.
31 have not considered the applicability of the rule to managers and majority
shareholders. However, insofar t as they owe duties to the company, it would
seem that the rule and its exceptions extend to them as well: Menier v.
Hooper's Telegraph Works (1874) L.R. 9 Ch.App. 350. Moreover, senior officers
seem now to owe the same duties at law to their company as directors:
CanadianAero Service Ltd v. O'Malley [1974] S.C.R. 592. Cf. also the Business
CorporationsAct, R.S.O. 1970, c.53, ss.144-47.
4R.S.O. 1970, c.53. Cf. also the Companies Act, S.B.C. 1973, c.18, s.222 and
Manitoba's proposed legislation, The CorporationsAct, Bill 37, 3d. Sess., 30th
Leg., 1976.
*
McGILL LAW JOURNAL
(Vol. 22
shareholders an opportunity to bring derivative actions on behalf
of their company to enforce the duties owed to it by its directors:
s.99.(1) Subject to subsection 2, a shareholder of a corporation may
maintain an action in a representative capacity for himself and all other
shareholders of the corporation suing for and on behalf of the corporation
to enforce any right, duty or obligation owed to the corporation under
this Act or under any other statute or rule of law or equity that could
be enforced by the corporation itself, or to obtain damages for any breach
of any such right, duty or obligation.
(2) An action under subsection 1 shall not be commenced until the
shareholder has obtained an order of the court permitting the shareholder
to commence the action.
(3) A shareholder may, upon at least seven days notice to the corporation,
apply to the court for an order referred to in subsection 2, and, if the court
is satisfied that,
(a) the shareholder was a shareholder of the corporation at the time
of the transaction or other event giving rise to the cause of the action;
(b) the shareholder has made reasonable efforts to cause the corporation to commence or prosecute diligently the action on its own
behalf; and
(c) the shareholder is acting in good faith and it is prima facie in
the interest of the corporation or its shareholders that the action
be commenced,
the court may make the order upon such terms as the court thinks fit,
except that the order shall not require the shareholder to give security
for costs.
(4)
At any time or from time to time while an action commenced under
this section is pending, the plaintiff may apply to the court for an order
for the payment to the plaintiff by the corporation of reasonable interim
costs, including solicitor's and counsel fees and disbursements, for which
interim costs the plaintiff shall be accountable to the corporation if the
action is dismissed with costs on final disposition at the trial or on
appeal.
(5) An action commenced under this section shall be tried by the court
and its judgment or order in the cause, unless the action is dismissed with
costs, may include a provision that the reasonable costs of the action are
payable to the plaintiff by the corporation or other defendants taxed as
between a solicitor and his own client.
(6) An action commenced under this section shall not be discontinued,
settled or dismissed for want of prosecution without the approval of the
court and, if the court determines that the interests of the shareholders or
any class thereof may be substantially affected by such discontinuance,
settlement or dismissal, the court, in its discretion, may direct that notice
in manner, form and content satisfactory to the court shall be given, at
the expense of the corporation or any other party to the action as the
court directs, to the shareholders or class thereof whose interests the
court determines will be so affected.
19761
RATIFICATION AND THE DERIVATIVE ACTION
The section must now be compared with the more ambitious
provisions of the Canada Business CorporationsAct.5 The Canadian
Act permits a "complainant" to apply to a court to bring a derivative
action under section 232 or to seek relief from oppression under
section 234. Unlike section 99(3)(a) of the Ontario Act, the Canadian Act does not require contemporaneous ownership, giving a
court discretion to allow anyone falling under the definition of
"complainant" in section 231 to bring an action. While the Ontario
Act is silent on the question of ratification, the Canadian Act states
in section 235(1):
An application made or an action brought or intervened in under this Part
shall not be stayed or dismissed by reason only that it is shown that an
alleged breach of a right or duty owed to the corporation or its subsidiary
has been or may be approved by the shareholders of such body corporate,
but evidence of approval by the shareholders may be taken into account
by the court in making an order under section ...233 or 234.
The new Ontario remedy has been criticized for a variety of
reasons.0 Because of the procedural requirements of section 99(3),
a derivative action will likely now be more costly and time-consuming than at common law under the exceptions to the rule in Foss
v. Harbottle.7 The shareholder must also show that it is prima facie
in the interest of the corporation or its shareholders that the action
be commenced at a time when he may have little or no access to
details of corporate wrongdoing. In imposing these restrictions, the
intention of the Select Committee on Company Law,s which drafted
the bill, was clearly to avoid strike suits. A company must be protected from a "cantankerous member"9 whose love of litigation injures the company (and its shareholders) more than it benefits the
shareholders. In the past, these fears would seem to have been
misplaced. In most cases, ordinary court costs ° and the prohibition
against contingent fees'- served as an adequate deterrent to harassing
litigation; and, as a matter of substantive law, the rule in Foss v.
5S.C. 1974-75, c.33.
1 Cf. T. A. Zacks, Comment (1973) 8 U.B.C.L.Rev. 191 and S. M. Beck, The
Shareholders' Derivative Action (1974) Can.Bar Rev. 159, 196 et seq.
infra, "The exceptions to Foss v. Harbottle", at 178.
8 1967 Interim Report, 5th Sess., 27th Leg., 15-16 Eliz.II, 62-63 (hereinafter
7See
called The Lawrence Report).
9 MacDougall v. Gardiner (1875) 1 Ch.D. 13, 25 per Mellish L. Cf. also Cie
de Mayville v. Whitley [1896] 1 Ch. 788, 807 per Kay LJ.
10 See L.C.B. Gower, Company Law - Minority Stockholder's Suits (1950)
19 M.L.R. 538, 541.
11 See The Lawrence Report, supra, note 8, 63. Cf. also W. B. Williston, The
Contingent Fee in Canada (1968) 6 Alta L.Rev. 184.
McGILL LAW JOURNAL
[Vol. 22
Harbottle seldom permitted recovery in derivative actions. But
under section 99 this may no longer be the case. Moreover, subsection (4) provides for an order of interim costs, including solicitor's
and counsel fees, contingent upon success or an award of costs in
the principal action. Under these circumstances, a requirement that
an initial prima facie case be made, showing that the action is for
the benefit of the company, may not be unreasonable. The section
should not be used for fishing expeditions where there is no evidence
that the director has committed a breach. How a shareholder learns
of the affairs of the company is in general a separate question,
determined by separate sections of the Act. 12 It is hardly necessary
to add that a full disclosure of business matters to shareholders may
not be in the company's interests. In any event, there is some flexibility in the wording of section 99(3) (c): it does not require the
plaintiff to make out his case at the pre-trial hearing, but merely to
show that the action should be commenced. 3 In appropriate cases, a
judge may therefore permit a shareholder to use discovery devices
where he has not fully made out a prima facie case. Finally, it must
always be remembered that even where a director is clearly in
breach of his duties, the prosecution of the action may be disadvantageous to the company and its shareholders. A trifling breach of
the duty of care, which causes only nominal loss, should not be
the subject of the elaborate machinery of section 99.14
' 2 Business Corporations Act, supra, note 4, ss.172-188.
13Re Marc-Jay Investments Inc. (1974) 5 Q.R. (2d) 235; see also Feld v.
Glick (1975) 56 D.L.R. (3d) 649 (Ont. H.C.).
14See R. N. Leavell, The Shareholders as Judges of Alleged Wrongs by
Directors (1961) 35 Tulaine L.Rev. 331, 348: "A suit against a corporation's
director ...even if successful, can sometimes.., do the corporation more
harm than good: his services may be lost; the standing of the corporation in
financial circles may be adversely affected; public relations may suffer; the
value of the shares may be adversely affected in the market; prosecution of
the action may be expensive to the corporation." See also S. Solomont &
Sons Trust v. New England Theatre Operating Co. 93 N.E. 2d 241 (1950,
Mass.Sup.Jud.Ct); Pomerantz v. Clark 101 F.Supp. 341 (1951, D.Mass.). A
similar problem was suggested in Claman v. Robertson 164 O.St. 61, 128 N.E.
2d 429 (1955). Can a director, as a shareholder, bring an action to avoid a
contract between himself and his company, where in spite of strict equitable
rules which make the contract voidable at the option of the company, the
contract has actually turned out to be profitable for it? If he cannot, can
any other shareholder do so? As a result of these difficulties, American courts
have granted "disinterested" directors a considerable discretion to prevent a
derivative action: see Swanson v. Traer 249 F.2d 854 (1957, 7th C.C.A.).
19763
RATIFICATION AND THE DERIVATIVE ACTION
PERSONAL ACTIONS
More serious problems arise with respect to the scope of section
99. Until recently, its principal effect would seem to have been in
preventing rather than permitting derivative actions. In Farnham
v. Fingold the Ontario Court of Appeal held that "the very broad
language of s.99(1) embraces all causes of actions under any
statute or in law or in equity, that a shareholder may sue for on
behalf of the corporation". 15 Since the plaintiffs had not applied
for leave under section 99(3), the Court did not consider the
merits of their claim for a declaration that the defendant shareholders held the premium obtained on a sale of controlling shares of
their company for the benefit of the company or its shareholders.
The Farnham decision was followed by the Ontario High Court in
Goldex Mines Ltd v. Revill. 16
7
The Goldex decision was affirmed by the Court of Appeal,' but
Brooke J.A. per curiam adopted to a large extent the critical analysis
of the previous decisions by Professor Beck.1 8 Professor Beck argued
that if derivative actions must now be brought under section 99,
the section does not purport to affect personal actions by shareholders, which may be brought without leave. A personal action lies
where a legal wrong is done to a shareholder or a group of share-
holders of the company. "A derivative action, on the other hand,
is one in which the wrong is done to the company."' 9 But since
Foss v. Harbottle it has been thought that directors' duties are in
general owed to their company and not to its shareholders. A shareholder's remedy for a director's breach would then in most cases
only lie under section 99.
However, after arguing that personal actions need not be brought
under section 99, Professor Beck suggested that "the personal rights
category is in fact much broader than has been thought to be the
case".2 0 The most interesting aspect of the decision of the Court
of Appeal in Goldex is its delicate flirtation with Professor Beck's
argument that directors may owe fiduciary duties to shareholders,
particularly in the realm of the "proper purposes" doctrine.2 1 If
directors' duties to act bona fide in the interests of the company as
15 [1973] 2 O.R. 132, 135 per Jessup I.A.
16 [1973] 3 O.R. 869.
17 (1974) 7 O.R. (2d) 216.
18 The Shareholders' Derivative Action (1974) 52 Can. Bar Rev. 159.
1 (1974) 7 O.R. (2d) 216, 221.
20 (1974) 52 Can.Bar Rev. 159, 170.
21 (1974) 7 O.R. (2d) 216, 222.
McGILL LAW JOURNAL
[Vol. 22
a whole and not purely for their personal objectives may be enforced
by personal actions by. shareholders, it is not clear why other duties
are owed only to the company. Is there any sense in which a breach
of the proper purposes rule is more "personal" than breaches of the
duties to act in good faith and with care and skill? The difficulty with
the distinction between personal and derivative actions is that every
injury to a company causes an injury to its shareholders. Brooke J.A.
would certainly require more than such an indirect injury to a shareholder to entitle him to sue.22 However, the case does suggest the
possibility that directors owe fiduciary duties to shareholders, who
may bring personal actions to enforce such duties without obtaining
leave under section 99. But this remains a mere possibility, whose
occurence would effect a revolution in Canadian company law. There
are as well eminently practical reasons why not every breach by a
director should give rise to a shareholder's private right of action.
In many cases, shareholder actions, if permitted, would harm a
company and its shareholders. 23 A screening device, such as section
99(3) of the Ontario Act may then be very useful. Private rights may
lead to a multiplicity of suits by each injured shareholder. Private
actions for the benefit of individual shareholders also defeat the
prior claim of creditors of the corporation, since recovery in such
cases is personal and not corporate. Finally, private rights may lead
to private settlements, with the faint suggestion of blackmail in the
background. Such settlements are unlikely under section 99(6) of
24
the Ontario Act.
One may therefore expect that directors will continue to owe
duties to their companies which are not owed directly to their shareholders. In such cases, the statutory remedy under section 99 is
exclusive. That is not to say, however, that the substantive rule in
Foss v. Harbottle is obsolete, although one may sympathize with the
hope of Hughes J. that, as a result of section 99, "it is to be expected
that much labour will be saved at the bench and bar in this Province
in raking the embers of abundant learning generated over the years
by Foss v. Harbottle".25 Notwithstanding section 99 the courts may
view derivative actions with the same disfavour as before. Firstly,
the section does not prescribe the circumstances under which an
action may be brought. Secondly, unlike the Canada Business Cor22 Ibid., 223.
23 Cf. R.N. Leavell, supra, note 14.
24 For the American position see Watson v. Button 235 F.2d 235 (1956, 9th
C.C.A.) and C.K. Crosno, Note, (1952) 40 Calif.L.Rev. 127.
25 Goldex Mines Ltd v. Revill [1973] 3 O.R. 869, 877.
19761
RATIFICATION AND THE DERIVATIVE ACTION
porations Act,26 section 99 says nothing of ratification. As a result,
one may presumably ratify any breach which could have been ratified
before the passage of the new Act. 27 Finally, and most importantly,
the possibility of ratification may determine the right to bring a
derivative action: a court may hesitate to permit an action which
may subsequently be undone by the company shareholders. This
"futility principle" was, after all, a principal basis for the decision
in Foss v. Harbottle. Thus the courts may still be forced to return to
the old learning of the cases when directors seek to avoid liability for
their breaches.
THE RULE IN FOSS v. HARBOTTLE
The rule in Foss v. Harbottle is one which, but for certain exceptions, prohibits a suit brought by an individual shareholder to
remedy a wrong done to the corporation. "In law the corporation
and the aggregate members of the corporation are not the same
thing for purposes like this.128 If it is alleged that the company has
suffered at the hands of a director, the proper plaintiff in an action
to remedy the injury is the corporation itself. 9 But the rule involves
more than a mere question of standing. If a company may sue its
directors, it may also ratify their breaches of duty through a majority
vote of shareholders in general meeting. The result is that
[w]hilst the court may be declaring the acts complained of to be void at
the suit of the ...[individual shareholders], who in fact may be the only
proprietors who disapprove of them, the governing body of proprietors
may defeat the decree by lawfully resolving upon the confirmation of the
very acts which are the subject of the suit.30
A mere possibility of ratification therefore prevents a shareholder
from suing a director for a breach of duty to his company.
As a result, much of the work of regulating a company's directors
was left to a majority of its shareholders. Courts were reluctant to
intervene in the "internal management" of a company, whose direc26 Supra, note 5, s.235.
27 Personal rights of shareholders cannot be lost by ratification, being an
"exception" to the rule in Foss v. Harbottle: See infra, at 178.
28 (1843) 2 Hare 461, 490; 67 E.R. 189, 202 per Wigram V.C.
2 Burland v. Earle [1902] A.C. 83, 93 per Lord Davey (P.C.); Edwards v.
Halliwell [1950] 2 All E.R. 1064, 1066 per Jenkins Li. (C.A.).
30 (1843) 2 Hare 461, 494; 67 E.R. 189, 203-4 per Wigram V.C. On the two
branches of the rule, see K. W. Wedderburn, supra, note 2. See also MacDougall
v. Gardiner (1875) 1 Ch.D. 13, 25 per Mellish L.J; North-West TransportationCo.
v. Beatty (1887) 12 App.Cas. 589, 593-94 per Sir Richard Baggallay (P.C.);
Burland v. Earle, ibid., per Lord Davey (P.C.); and Edwards v. Halliwell, ibid.
McGILL LAW JOURNAL
[Vol. 22
tors and members were assumed to have far greater expertise in the
conduct of its affairs than judges. In 1843, that may well have been
the case. But today few commentators would credit ordinary shareholders with much knowledge of their company.-' They are seen
rather as mere rentiers of capital, interested only in the security
and return on their investment, and hardly capable of casting an
intelligent vote in the ratification of a director's breach. 2 However,
even were this not the case, conflicts of interests between controlling
shareholders or directors and minority shareholders may justify
intervention by the courts. In these cases, an abdication of judicial
31 The impotence of the average shareholder was first demonstrated in T.
Veblen, Absentee Ownership and Business Enterprise in Recent Times: The
Case of America (1923); Ripley, Main Street and Wall Street (1927); and the
classic treatise of A. A. Berle and G. C. Means, The Modern Corporation and
Private Property (1932). Since then, the topic has received wide attention
throughout the common law world. See B. Manning, Book Review (1958) 67
Yale L.J. 1477; Corporate Power and Individual Freedom: Some General
Analysis and ParticularReservations (1961) 55 Nw. U.L. Rev. 38; M. A. Pickering,
Shareholders' Voting Rights and Company Control (1965) 81 L.Q.R. 248, 269
et seq.; and B. Hindley, Separation of Ownership and Control in the Modern
Corporation(1970) 13 J. of Law and Econ. 185.
Some writers are, however, still willing to rally round the doctrine of
Corporate Democracy: See F. D. Emerson and F. C. Latcham, Shareholder
Democracy (1954); F. A. von Hayek, "The Corporation in a Democratic Society:
In Whose Interest Ought It and Will It be Run?" in Aushen and Bach (eds),
Management and Corporations 1985 (1960), 99; and N.W. Chamberlain, The
Limits of Corporate Responsibility (1973). It is sometimes argued that the
rise of institutional investors in the last two decades will offer a greater protec-
tion to minority shareholders, although that proposition has not passed with-
out criticism: see D. L. Ratner, The Government of Business Corporations:
Critical Reflections on the Rule of 'One Share, One Vote' (1971) 56 Cornell
L.Rev. 1. Cf. M. A. Eisenberg, who argues that commentators have been misled
by "the A.T. & T. myth", and that many shareholders have a sufficient investment in their company to entitle them to have a say in corporate decisions:
The Legal Roles of Shareholders and Management in Modern Corporate
Decisionmaking (1969) 57 Calif.L.Rev. 1.
32 Several commentators have suggested that one might therefore do away
with shareholder voting rights altogether: B. Manning, Book Review, ibid.,
1486-90; A. Chayes, "The Modern Corporation and the Rule of Law" in E. S.
Mason (ed.), The Corporation in Modern Society (1959), 25. This has been
criticized by H. G. Manne, who argues that shareholder voting rights are necessary to preserve the market for corporate acquisitions, which in turn is a
useful incentive to managerial efficiency: The "Higher Criticism" of the
Modern Corporation (1962) 62 Colum.L.Rev. 399; Some Theoretical Aspects of
Share Voting (1964) 64 Colum.L.Rev. 1427; and Mergers and the Market for
Corporate Control (1965) 73 1. of Pol. Econ. 110. But cf. A. A. Berle, Modern
Functions of the CorporateSystem (1962) 62 Colum.L.Rev. 433 and D. C. Morse,
Economic Realities of Cash Tender Offers (1968) 20 Maine L.Rev. 237.
1976]
RATIFICATION AND THE DERIVATIVE ACTION
control to majority rule is entirely inappropriate. In a close corporation, a minority shareholder may find it impossible to prevent
the ratification of a breach because of the voting control of the
transgressor. Where the company's shares are widely held, a dissenting shareholder is not likely to have the financial resources or the
support of the other shareholders to wage a campaign to prevent
ratification. By contrast, the controlling shareholders or directors
are highly organized, and can usually obtain the forgiveness of their
sins through their control of the proxy apparatus.
RESTRAINTS ON AVOIDING LIABILITY THROUGH
RATIFICATION
1. Close corporations
While the principle of noninterference in internal company affairs
seems to have been derived from partnership law, 3 the courts have
been less willing to apply to shareholders the duties of good faith
which partners owe to each other.34 A suggestion has been made in
a few cases that majority shareholders must exercise their powers as
fiduciaries. Thus in Allen v. Gold Reefs of West Africa Ltd Lindley
M.R. stated that the majority must exercise its voting powers "bona
fide for the benefit of the company as a whole".35 However, that
restriction seems now to be limited to the special case of an amendment to the articles of the company 3 6 In other cases, the rule is in
general that stated by Jessel M.R. in Pender v. Lushington:3T
There is, if I may say so, no obligation on a shareholder of a company to
give his vote merely with a view to what other persons may consider the
interests of the company at large. He has a right, if he thinks fit, to give
his vote from motives or promptings of what he considers his own
individual interest. 38
The case most often cited for this rule is North-West Transportation
Co. v. Beatty,3 9 in which a director sold to his company a steamer
33
See K. W. Wedderburn, supra, note 2.
34 Blisset v. Daniel (1953) 10 Hare 493, 536; 68 E.R. 1022, 1040.
a5 [1900] 1 Ch. 656, 671 (C.A.). See also Ritchie v. Vermillion Mining Co.
(1902) 4 O.L.R. 588, 604 per Moss J.A.
36 Or where class rights are provided for bondholders in a trust deed:
British America Nickel Co. v. M. J. O'Brien Ltd [1927] A.C. 369 (P.C.). See
generally B. H. McPherson, Oppression of Minority Shareholders (1963) 36
A.L.J. 404.
37 (1877) 6 Ch.D. 70. But cf. the discussion on Menier's case, infra, at 183.
38 Ibid., 75-76.
39 (1887) 12 App.Cas. 589 (P.C.); rev'g (1886) 12 S.C.R. 598; aff'g (1885) 11
O.A.R. 205; rev'g (1883) 6 O.R. 300.
McGILL LAW JOURNAL
[Vol. 22
which he had built and owned. While the director acted in good
faith and the contract would seem to have been fair, it was voidable
tinder the rule in Aberdeen Rail. Co. v. Blaikie Bros.40 However, the
director controlled 301 of the 600 issued shares of the company, and
qua shareholder procured the ratification of the contract at a general
meeting of the company. In the Supreme Court of Canada, it was
held that the rule in Pender v. Lushington did not apply where a
shareholder, as a director, owed special duties to his company. The
judgment was reversed by the Privy Council, Sir Richard Baggallay
stating that
...
every shareholder has a perfect right to vote upon any such question,
although he may have a personal interest in the subject-matter opposed
to, or different from, the general or particular interests of the company.4 1
There is consequently little to prevent a controlling shareholder
in a close corporation from avoiding all liability for ratifiable
breaches.
2. Widely-held corporations
In a widely-held company different problems arise. The element
of control by management may be based not on ownership of shares
but solely on its entrenched position. "[C]ontrol may be held by the
directors or titular managers who can employ the proxy machinery
to become a self-perpetuating body, even though as a group they
own but a small fraction of the stock outstanding.142 While any
shareholder may send out proxies, at law only the directors may do
so at the expense of the company. 43 The proxy apparatus has there(1854) 1 Macq.H.L. 461 (Sc.), [1843-60] All E.R. Rep. 249.
41(1887) 12 App.Cas. 589, 593 (P.C.). See also Ritchie v. Vermillion Mining Co.,
supra, note 35, 594-95 per MacLennan J.A.; Dominion Cotton Mills Co. v. Amyot
[1912]
A.C. 546 (P.C.).
42
A. A. Berle and G. C. Means, supra, note 31, 5.
43
Peel v. London and North Western Ry. Co. [1907] 1 Ch. 5 (C.A.); Campbell
v. Australian Mutual Provident Soc. (1908) 77 L.J.P.C. 117. Under s.102 of the
Business Corporations Act, supra, note 4, shareholders holding 5% of the
voting shares may require that a proposed shareholder resolution with a
statement of not more than 1,000 words be sent to all shareholders before
a shareholder meeting. The shareholders must give security for costs, which
will not be repaid unless they obtain the support of the majority of shareholders. A similar right exists with respect to a requisition for a general
meeting; s.109. Because of the need for the initial support of 5% of the
shareholders and the approval of a majority for reimbursement, neither
provision is likely to be used except in a takeover bid.
S.131 of the Canada Business Corporations Act, supra, note 5, which
closely resembles SEC Rule 14a-8, does away with both difficulties for shareholder proposals. S.137 of the Act gives shareholders substantially the same
right to requisition a meeting as the Ontario Act.
40
19761
RATIFICATION AND THE DERIVATIVE ACTION
fore been the subject of substantial regulation in both the United
States and Canada. Under the Ontario Act, every proposal by management in a proxy must be accompanied by a brief discussion of the
substance of the matter "in sufficient detail to permit shareholders
to form a reasoned judgment concerning any such matter".4 4 Moreover, a special duty of disclosure is required at law of directors who
seek to ratify a breach: "Ratification consists in adopting something
which has been done or assumed to have been done for the person
ratifying with full knowledge that it has been done. '4' The requirement of full disclosure is by definition a necessary condition of
ratification, quite apart from the proxy rules. Thus in Pacific Coast
Coal Mines, Ltd v. Arbuthnot46 a shareholder resolution which released the directors of a company from its claims against them was
set aside by the Privy Council for lack of adequate disclosure to the
shareholders:
If the shareholders were to release possible claims, they ought to have
been told of the grave character which ...[had been] attributed to the circumstances out of which [it was] alleged that they had arisen. Nor was
there anything to tell them that as the result of the settlement [one of
the directors] ...would quit the company with large profits in his
pocket. 47
An adequate notice should therefore not only describe the breach,
but also specify all profits or commissions made by a director
48
through it.
Proxy rules present courts with a procedural device with which
they may invalidate unfair shareholder resolutions. The rules also
provide shareholders with their most useful source of information
about the company." And yet, doubts remain. Even the fullest
disclosure to shareholders may not protect the company adequately
from a rapacious management:
Perhaps the most serious charge against the myth of shareholder democracy is that its slogans do much to create an impression in the public
mind.., that a degree of shareholder supervision exists which in fact does
not. It is quite arguable that the net effect of the corporate Jacksonians
44
Business CorporationsAct, supra, note 4, s.118(1)(a) and Ont.Reg. 492/70,
Form 15, Item 10. Cf. also Canada Business CorporationsAct, supra, note 5,
s.143 and SOR/76-22, s.33 et seq. Apart from the statutes, a substantial duty of
disclosure exists at law: Garvie v. Axmith (1961) 31 D.L.R. (2d) 65 (Ont. H.C.).
45
Ashbury v. Watson (1885) 30 Ch.D. 376, 381 per Lord EsherM.R.
46 [1917] A.C. 607 (P.C.).
41 Ibid., 618 per Viscount Haldane. See also Gray v. Yellowknife Gold Mines
Ltd
(No.d) [1947] O.R. 928, 962 per Laidlaw J.A.
48
See also Rountree v. Sydney Land and Loan Co. (1908) 39 S.C.R. 614.
49 L. Loss, Securities Regulation 2d ed. (1961), vol.II, 1027.
McGILL LAW JOURNAL
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has been to impede their ultimate objective of responsible corporate
management. The forms and mechanisms of shareholder democracy divert
attention from the real problem of holding business managements to a
desirable standard of responsibility ... . The reform efforts of the
Corporate Democrats, seen in this light, appear fundamentally misplaced,
misdirected and romantic. 50
3.
The exceptions to Foss v. Harbottle
In Foss v. Harbottle itself, Wigram V.C. held that some breaches
are incapable of majoritarian ratification.5 The rule is therefore
said to be subject to various exceptions, of which the classic enumer52
ation is that of Jenkins L.J. in Edwards v. Halliwell:
(1)
(2)
(3)
(4)
"where the act complained of is wholly ultra vires the company ...
where "the personal and individual rights of membership ... have
been invaded...";
where the matter is "one which could validly be done or sanctioned
not by a simple majority of the members of the company ... but
only by some special majority ... "; and
"where what has been done amounts to ... a fraud on the minority
and the wrongdoers are themselves in control of the company...53
In addition to these exceptions, Professor Gower has suggested
that ratification is impossible "where the interests of justice require
that the general rule... should be disregarded". 4 While such a rule
was expressly rejected by Danckwerts J. in Pavlides v. Jensen,"
and by the Ontario High Court in Ellis v. McQueen,r0 other Canadian
decisions have been less reluctant to accept a fifth exception.57
In Teck Corp. v. Millar,for example, Anderson J. held that a minority
shareholder might sue on that basis 8 A court may therefore be
forced to consider basic questions of fairness and justice where an
attempt is made to ratify a director's breach.
50 B. Manning, Book Review, supra, note 31, 1489-90.
51 (1843) 2 Hare 461, 492, 67 E.R. 189, 203.
52 [1950] 2 All E.R. 1064 (C.A.).
53 Ibid., 1067.
5 L.C.B. Gower, The Principlesof Modern Company Law 3d ed. (1969), 585.
55 [1956] Ch. 565; cf. L. S. Sealy, Cases and Materials in Company Law (1971),
693.
50 (1967) 63 D.L.R. (2d) 678.
57 Waddell v. The Ontario Canning Co. (1889) 18 O.R. 41, 49-50 per Robertson J.; Charlebois v. Bienvenu (1967) 64 D.L.R. (2d) 683, 695 per Fraser J. (Ont.
H.C.); rev'd on other grounds (1968) 68 D.L.R. (2d) 578; and Schiowitz v.
I.O.S. Ltd (1971) 23 D.L.R. (3d) 102, 120 per Hughes J.A. (N.B. C.A.). See also
Wallersteiner v. Moir (No.2) [1975] 1 Q.B. 373, 390-91 per Lord Denning M.R.
(C.A.).
58
Unreported judgment, 23 June, 1972, no.16244 (B.C. S.C.); cf. the Court of
Appeal decision, (1972) 33 D.L.R. (3d) 288, 292-93 per Berger J.
19761
RATIFICATION AND THE DERIVATIVE ACTION
These are only exceptions to the first branch of the rule in
Foss v. Harbottle, which prohibits an action by an individual
shareholder in matters of internal corporate management. They
are not exceptions to the rule against shareholder action where
ratification is possible, since a breach which may be subsumed
under any one of the exceptions is not capable of ratification by
a simple majority of shareholders- 9
A right of action under the first three exceptions is personal,
and is not affected by section 99P0 Notwithstanding the decision
in Goldex Mines Ltd v. Revill, actions brought under either of the
last two exceptions are derivative and must comply with the requirements of that section. But decisions which upheld the right
of shareholders to bring derivative actions in the past are still
relevant in determining whether a breach may be ratified. If a
derivative action was not allowed, ratification was then and is
likely still permitted. The converse, as pointed out above,"1 is that
the determination of whether or not a breach is ratifiable may be
the criterion of whether a derivative action is permitted under
section 99. The vexed question of the distinction between ratifiable
and non-ratifiable breaches would then have lost none of its importance.
RATIFIABLE BREACHES
1. Care and skill
Of the director's duties, the least exacting has generally been
his obligation to use care and skill in discharging his functions.
Even where a director was grossly negligent in selling company2
assets at an undervalue, his breach was held capable of ratification.
59 Cf. Foss v. Harbottle,supra, note 1, and Ashbury Ry. Carriageand Iron Co.
v. Riche (1875) L.R. 7 H.L. 653 (ultra vires); and Pender v. Lushington, supra,
note 37, 81 per Jessel M.R. (personal rights).
GOA shareholder's right to ensure that company statutes or articles are
complied with is personal: Pender v. Lushington, supra, note 37; Hutton v.
West Cork Ry. Co. (1883) 23 Ch.D. 654 (C.A). A group of shareholders with
personal causes of action against their company may sue as a class under
Rule 75 of the Ontario Rules of Practice. Their representative or class action
must, however, be distinguished from the derivative action of a shareholder
whose claim is on behalf of his company and not himself; see Farnham v.
Fingold [1972] 3 O.R. 688 and J. A. Kazanjian, Class Actions in Canada (1973) 11
Osgoode Hall L.J. 397; see also infra, note 64.
01 See supra, at 173.
2
Pavlides v. Jensen, supra, note 55. A director may not be indemnified for
any liability in connection with the execution of his duties under s.147 of the
McGILL LAW JOURNAL
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While one might hope for a wider scope of liability under the
restatement of the duty in section 144 of the Ontario Act, there
is nothing to suggest that a director's careless acts may not be
ratified. The principal impetus to managerial efficiency is not the
derivative action but the market for corporate takeovers.
2.
Breaches of authority
Like ordinary agents, directors may not act in excess of their
authority.6 3 When they do, such breaches of authority may normally
be ratified by the corporation. But where the breach is of the
articles of a company, the cases are in complete disarray. 5 The articles have been held to constitute a contract, under which shareholders
have personal rights against the company. In addition, a special
majority is required in all jurisdictions in Canada to alter the articles
Ontario Act, supra, note 4. However, unlike indemnification, ratification is not
usually thought merely to save the director from the consequences of a breach.
Rather, it nullifies the breach: F.M.B. Reynolds and B. J. Davenport (eds),
Bowstead on Agency 13th ed. (1969), 57. The Canada Business Corporations
Act, supra, note 5, s.117(3) goes further in providing that no resolution may
relieve a director from liability for a breach of his duties under the Act or
the Regulations. This might make ratification impossible in these cases, although it may be possible to draw a distinction between relief from the
consequences of a breach and its nullification by ratification. The very broad
ambit of s.117(3) certainly encourages such an interpretation. The alternative
would appear to result in an absolute prohibition of ratification, except in those
few cases where duties at law cannot be found in the statute.
63
Picard v. Revelstoke Saw Mill Co. (1913) 12 D.L.R. 685 (B.C. C.A.), var'g
(1913) 9 D.L.R. 580.
64
1rvine v. Union Bank of Australia (1877) 2 App.Cas. 366; Grant v. United
Kingdom Switchback Rys. Co. (1888) 40 Ch.D. 135 (C.A.); Adams v. Bank of
Montreal (1903) 32 S.C.R. 719; Bamford v. Bamford [1970] Ch. 212, 23940 per
Harman L.J. (C.A.).
A distinction must of course be drawn between an ordinary breach of the
director's authority and an act ultra vires the company which cannot be
ratified; see Cie de Villas du Cap Gibraltar v. Hughes (1884) 11 S.C.R. 537
per Ritchie C.J.
65 See K. W. Wedderburn, supra, note 2, 210 et seq. and S. Chumir, Challenging Directorsand the Rule in Foss v. Harbottle (1965) 4 Alta L.Rev. 96.
46
G The doctrine of the contractual effect of the articles is of English origin;
see Hickman v. Kent or Romney Marsh Sheepbreeders' Ass'n [1915] 1 Ch. 881
and cases cited therein. Some doubt has therefore been cast upon its applicability to Canadian letters patent jurisdictions. However, F. W. Wegenast stated
"that the relationship established by the letters patent may be regarded as
contractual in effect if not in origin": Law of Canadian Companies (1931),
247. The cases on point are not as clear as one might wish; see S. M. Beck, "An
Analysis of Foss v. Harbottle", supra, note 2, 581 et seq.
1976]
RATIFICATION AND THE DERIVATIVE ACTION
of a company for most if not all purposes. 6 7 These breaches would
therefore appear to be examples of the third exception to Foss v.
Harbottle, and incapable of ratification by a simple majority. 8
However, other cases have suggested a distinction between altering
and ratifying a breach of the articles."9
In his detailed study of the question, Professor Wedderburn
argues that previous explanations of the different results in the
cases are unsatisfactory, and suggests a rule of exclusion: a shareholder has in general the right to enforce the articles except in cases
where a court has denied such a right in a similar case." Unfortunately, one may argue with equal authority that the rule works the
other way: any breach may be ratified except those where individual
shareholder suits were permitted. However, both rules are quite
nominalistic and neither is a satisfactory solution to the question.
3.
Mere irregularities
Shareholders may not complain of a "mere informality or irregularity which can be remedied by the majority". 1 The locus
2
where a director,
classicus of this rule is MacDougall v. Gardiner,7
as chairman of a shareholders' meeting, refused a poll on a vote of
adjournment. The plaintiff argued that this was done to stiffle
a shareholders' revolt, and that it was contrary to the articles of
the company. The defendants demurred, and the Court of Appeal
held that, notwithstanding the alleged breach of the articles, the
plaintiff had no cause of action:
[N]othing connected with internal disputes between the shareholders is
to be made the subject of a bill by one shareholder on behalf of himself
and others, unless there be something illegal, oppressive or fraudulent...
on the part of the company ... or ... the majority of the company...
3
This ignores, of course, problems created by other exceptions
to Foss v. Harbottle.It is not enough to label a breach of the articles
as a mere irregularity - one must also distinguish irregularities
67E.g., Business Corporations Act, supra, note 4, s.189; Canada Business
Corporations Act, supra, note 5, s.167.
68 Although no case has held that a director who votes as a shareholder in
such a situation is subject to any fiduciary duties apart from the requirement of a special majority.
69 See Grant v. United Kingdom Switchback Rys. Co., supra, note 64, 139
and the other cases cited in note 64.
70 K. W. Wedderburn, supra, note 2, 214-25.
71 Burland v. Earle, supra, note 20, 93-94 per Lord Davey (P.C.).
72 (1875) 1 Ch.D. 13.
73 Ibid., 21-22 per James LJ.
McGILL LAW JOURNAL
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from breaches of articles which give shareholders personal rights
of action, or which can only be ratified by a special majority. As
one might expect, the distinction is no more clear 74 than that
between the ratifiable and non-ratifiable breaches of directors'
authority, described in the previous section. However, in spite of
the difficulties of definition, a distinction should be made between
non-ratifiable breaches of the articles and mere irregularities for
which a shareholder may not sue. Provisions for orders of compliance
with the articles, such as sections 261 of the Ontario Act, may be of
some help in this respect. The section does not give a shareholder
a right to enforce the rules governing the company, but only to
ask a court to do so. It is unlikely that every breach will be enjoined
by the court, especially since a shareholder may complain of a
breach of the by-laws as well as of the articles. A balance must
therefore be struck between true grievances and technical breaches
which really injure no one. The utility of section 261 is that it permits
the courts to articulate such a broad rule without considering the
hopelessly contradictory cases on a shareholder's right to enforce
the company articles."5
NON-RATIFIABLE BREACHES
Of the exceptions to Foss v. Harbottle, the one most often argued
when a director's breach of duty is in question is "fraud on the
minority". That exception (apart from the special case of alteration
of the company's articles) is usually said to encompass two fundamental duties: (1) not to expropriate corporate assets; and (2) to
act bona fide in the best interests of the company.
1. Expropriation of corporate assets
Lord Davey found in 1902 that the expropriation of a company's
assets was already a "familiar example" '0of fraud on the minority.
t4 Pender v. Lushington, supra, note 37 (shareholder wrongfully denied his
right to vote); Edwards v. Halliwell, supra, note 52; Peterson v. Cook [1923)
1 W.W.R. 1212 (Sask. K.B.) (requirement that a matter be referred to a special
majority of shareholders ignored by directors). See also, supra, note 65.
75 It may be that shareholders who in the future complain of a breach of the
articles may be forced to rely on s.261 of the Ontario Act if the courts, by
analogy to their interpretation of s.99 in the Farnham decision, supra, note
15, hold that s.261 excludes the remedy at law. See also Tycoos Dev.elopments
Ltd v. Cookstown Estates Ltd (1974) 2 O.R. (2d) 574, aff'd (1974) 3 O.R. (2d)
466 (C.A.) on the interpretation of s.16 of the Act. However, both ss.16 and 99
make significant procedural demands upon the plaintiff-shareholder. S.261 has
no such requirements.
7GBurland v. Earle, supra, note 29, 93.
19761
RATIFICATION AND THE DERIVATIVE ACTION
In discussing the case "where the majority are endeavouring directly
or indirectly to appropriate to themselves money, property or
advantages which belong to the company"," he referred to Menier
v. Hooper's Telegraph Works.78 There the European and South
American Telegraph Company had been formed to lay a transatlantic
cable for which it sought a license from the Brazilian government.
One of the company's directors obtained the license in his own name,
and organized a second company to exploit it. An injunction sought
by the European company against the personal use by the director
of the license was refused on balance of .convenience without a
determination of who was its rightful owner. Plans were made to
appeal the judgment when the defendant, as majority shareholder
in the European company, had a resolution passed abandoning
the appeal and winding up the company. For this service, the
defendant received a large payment from a third company, in
league with the director's new company. Both Mellish and James
L.JJ. held that the side payment amounted to a sale of corporate
assets for the sole benefit of the defendant, Hooper's Telegraph
Works. The minority shareholder who brought the action therefore
had standing to complain of the defendant's conduct; if not "the
majority might divide [among themselves] the whole assets of
the company, and pass a resolution that everything must be given
to them, and that the minority should have nothing to do with it".7 9
It will be noted that the defendant owed a duty not to expropriate
company assets even though not a director. Menier's case is thus
an interesting example of how, for some purposes, a majority
shareholder may be a fiduciary of the company. But the case is
among the most confusing in company law. In particular, how is it
that the secret commission came to be an asset of the European
company? It was never judicially determined that the company
had any right to the license. The company's right was to the
bribe paid to the defendant. However, since "that old enfant
terrible of restitution", 80 Lister & Co. v. Stubbs,"' such a right has
usually been considered to be personal and not proprietary. In
that case, the defendant was a general purchasing agent of the
plaintiff manufacturing company. In the course of his purchases
77 Ibid.
78 Supra, note
3.
79 Ibid., 353 per James LJ.
8OD.M.W. Waters, The Constructive Trust (1964), 283.
81 (1890) 45 Ch.D. 1 (C.A.); see also Metropolitan Bank v. Heiron (1880) L.R.
5 Ex.D. 319 (C.A.).
McGILL LAW JOURNAL
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from one company, Stubbs received large secret commissions for
placing orders with it. His employer brought an action to recover
the money, but before any judgment was reached the employer
sought an injunction to prevent Stubbs from dealing with the
real estate in which a portion of the bribes had been invested.
The plaintiff's right to recover the bribes was never doubted, but
the claim to follow the money failed. The relationship between the
parties was one of debtor and creditor, and not of trustee and
cestui que trust. While the money was owed to Lister & Co., the
company did not yet own it in equity.
It has been suggested that the rule in Lister & Co. v. Stubbs
can be narrowed to a question of procedure. A trust relationship
may be created by a court, but until that time a cestui que trust
has no proprietary interest in the asset. This was clearly the view
of Rand J. in McLeod v. Sweezey:
The holding [in Lister & Co. v. Stubbs] ... was strictly limited and it was
to the effect that, until the right of the plaintiff to money of the sort in
question had been established by a judgment, the court would not assist
him in pursuing it into other forms of property.8 2
The plaintiff's mistake in Lister & Co. v. Stubbs was therefore to
assert a proprietary right before it had been properly created by
the court. If the judgment may be so restricted, the bribes in
Menier's case may well be seen as corporate assets. However,
most commentators agree that the principle in Lister & Co. v.
Stubbs involves a substantial rule of equity.83 If so, the bribes
were not, strictu sensu, corporate assets. They belonged solely to
Hooper's Telegraph Works, although it was under a personal obligation to give them to the European company.
One way around this difficulty is to say that corporate assets
need not belong to the company under a constructive trust, since
the right to trace in equity, and standing under Foss v. Harbottle
are quite different matters with quite possibly different concepts
of corporate assets. Something less than full proprietary rights
under a trust may be sufficient to establish a fraud on the minority.
82 (1944) S.C.R. 111, 117. Cf. the discussion in D.M.W. Waters, supra, note 80,
336 on Lister & Co. v. Stubbs; and H.E.P.C. v. Brown (1959) 21 D.L.R. (2d) 551
(Ont. C.A.).
8
3R.
J. Oerlon (ed.), Underhill's Law Relating to Trusts and Trustees 12th
ed. (1970), argues that Stubbs was not a fiduciary, and suggests at 241 that it
might be otherwise in cases of "an exceptionally fiduciary character".
Directorships are apparently not of such a character; ibid., 240. Cf. L.C.B.
Gower, supra, note 54, 555, and R. Goff and G. Jones, The Law of Restitution
(1966), 459-60.
1976]
RATIFICATION AND THE DERIVATIVE ACTION
But it is just this full equitable ownership which has been urged
as the basis for a distinction between ratifiable and non-ratifiable
uses of company property. Thus in Cook v. Deeks 84 Lord Buckmaster L.C., purporting to follow Menier's case, distinguished "the
case of a director selling to his company property which was in
equity as well as at law his own, and which he could dispose of
as he thought fit" from that "of a director dealing with property
which, though his own at law, in equity belonged to his company". 85
The defendants had negotiated a contract, ostensibly as company
representatives, but in reality on their own behalf. This was held
a breach of their fiduciary duties as directors; nor were they able,
as majority shareholders, to ratify the breach. The benefit of the
contract "belonged in equity to the company and ought to have
been dealt with as an asset of the company".""
On the other hand, several members of the House of Lords
suggested in Regal (Hastings) Ltd v. Gulliver8
that directors'
breaches in a similar situation might be ratified. There, it will be
recalled, the directors of a company purchased shares in a second
company when it appeared that the parent company was financially
unable to organize it as a wholly-owned subsidiary. Notwithstanding
the directors' good faith, they were held liable for profits made
from the sale of the shares they had purchased, under the strict
8
However, Lord Russell stated that
rule of Keech v. Sandford.1
"[t]hey could, had they wished, have protected themselves by a
resolution (either antecedent or subsequent) of the Regal shareholders".,9
Professor Gower would distinguish these cases along the lines
of the "equitable property" doctrine.9 0 In Cook v. Deeks, the directors
were under a duty to acquire a contract for their company, and
their personal appropriation of the benefit of the contract was an
expropriation of assets which belonged in equity to the company
84
[1916] 1 A.C. 554 (P.C.).
85 Ibid., 563.
86 Ibid., 564. "In Cook v. Deeks resolutions were in question which disclaimed
on behalf of a company any interest in a contract made by persons who were
directors of -the company and who formed the majority of shareholders
passing the resolutions. They were in fact constructive trustees of the benefit
of the contract": Peters' American Delicacy Co. v. Heath (1939) 61 C.L.R. 457,
506 per Dixon J.
87
[1942] 1 All E.R. 378.
(1726) Sel.Cas.Ch. 61; 25 E.R. 223.
s Supra, note 75, 389; ef. 382 per Viscount Sankey and 394 per Lord Wright.
9o L.C.B. Gower, supra, note 54, 565-66.
88
McGILL LAW JOURNAL
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and therefore not ratifiable. But in Regal, the directors were under
no duty to subscribe for the shares, which never belonged to the
parent company. On the sale of the shares the directors made a
mere "incidental profit","' for which they were liable to account,
like Stubbs, to their company. The company could therefore have
ratified the breach and allowed them to keep the profits. Under
Professor Gower's theory, it would appear that most bribes paid to
directors may be ratified.
One may hesitate before accepting a view which would allow
directors to escape the consequences of their breaches in such a
large class of corporate fraud. Happily, the "equitable property"
test is hardly immune to criticism. It rests, first of all, on a substantive interpretation of Lister & Co. v., Stubbs92 which has not
passed without criticism in the Supreme Court of Canada. 3 Further,
there is little authority, other than the dicta in Regal, to support it.9 4
On the contrary, it would seem to have been rejected not only by
the Court of Appeal in Menier's case, but possibly as well by the
Supreme Court of Canada in Zwicker v. Stanbury.95 In that case,
the majority shareholders of a company on the verge of liquidation
surrendered their shares to the company's directors, who also purchased second mortgage bonds from the shareholders at one-half
their face value. The directors' interest in these transactions arose
from their belief that they could persuade the company's first mortgage bondholders to accept a scheme of refinancing. The directors
could not be said to have been under a duty to acquire the shares for
their company since the company could not hold its own shares.
Speaking for a majority of the Court, Kellock J. stated that the
directors "both in their acquisition of the shares and the second
mortgage were arrogating to themselves a secret profit"," and
held that the plaintiff shareholder had standing to bring a derivative
action against the directors under the rule in Menier's case. The
actual basis of the decision is left somewhat in doubt by Kellock
J.'s statement that "Etihey did not obtain the consent of the shareholders and both transactions, therefore, for the reasons stated,
cannot stand".9 7 If, like Lord Wright, to whom he referred imme-
diately above, Mr Justice Kellock would permit ratification, we
91
Ibid., 565.
92
Supra, note 81.
note 82.
93 Supra,
94 One
such case is Robinson v. Randfontein Estates (1921) A.D. 168 (S.A.).
95 [1953] 2 S.C.R. 438.
96 Ibid., 451.
97bid.
1976]
RATIFICATION AND THE DERIVATIVE ACTION
have here a true exception to Foss v. Harbottle - a case where
shareholders may complain of a ratifiable breach. But the quoted
sentence is not a paradigm of lucidity and it is suggested that the
rule in Foss v. Harbottle is so well established that something
more is required to overrule it.98
It may also be exceedingly difficult, as Gower recognizes, 99 to
distinguish corporate assets from mere personal obligations owed
to the company. Corporate assets include not only the company
till, but also opportunities which a director has a duty to acquire
for his company. Where secret profits are made by directors
through the use of a corporate opportunity, they become trustees
of the profit for the true corporate owner of the opportunity. 10 0
It is not necessary to prove in these cases that the opportunity
would have fallen to the company had it not been diverted by the
director.' 01 But there are cases where it is clear that while the
director might have profited from the opportunity, the company,
for one reason or another, could not: the seller might not have been
willing to deal with the company; 102 the company might not have
been able to finance the transaction; "o3 or the company might have
been prevented from making use of the opportunity by legal
restraints.' °4 In such cases, it is difficult to speak of a "corporate"
opportunity.
The concept of property has also been greatly stretched in an
effort to do justice between the parties. For example, the management of a public company has a duty to make a market for its
shares. But in what sense can it be said, as the Maryland Circuit
98 It has been suggested, however, that such an exception may be found in
Hogg v. Cramphorn Ltd [1967] Ch. 254 and Bamford v. Bamford [1970]
Ch. 212 (C.A.). See L.C.B. Gower, supra, note 54, 585-86, and K. W. Wedderburn,
Note (1967) 30 M.L.R. 77, 82-83 and infra, at 189-191.
99 L.C.B. Gower, supra, note 54, 554-56.
100 Henry v. Hammond [1913] 2 K.B. 515, 522.
101 CanadianAero Service Ltd v. O'Malley, supra, note 3.
102 Keech v. Sandford, supra, note 88.
103 Regal (Hastings)Ltd v. Gulliver, supra, note 87.
104 Cf. Zwicker v. Stanbury, supra, note 95. Other difficulties may arise in
parent-subsidiary situations: contrast David J. Greene & Co. v. Dunhill International Inc. 249 A.2d 429 (1969, Del.Ch.) and Sinclair Oil Corp. v. Levien 280
A.2d 717 (1971, Del.S.C.); or where a director owes a duty of loyalty to more
than one company; contrast Atkins and Durbrow Ltd v. Beil (1957) 10 D.L.R.
(2d) 484 (B.C. C.A.) and In re Investors Management Co., Securities and
Exchange Act Release 9267, 29 July 1971 with Boulting v. Ass'n of Cinematograph, Television and Allied Technicians [1963] 2 Q.B. 606 (CA.) per Lord
Denning M.R. and Black v. Shearson, Hammill & Co. 72 Cal.Rptr. 157 (1968,
Calif. C.A.).
McGILL LAW JOURNAL
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Court found in United Funds, Inc. v. Carter Products, Inc., that
a listing on the New York Stock Exchange is a valuable corporate
asset? ' The suggestion in Boardman v. Phipps1 0 1 that confidential
information may be property would further expand the definition
of corporate assets, so far in fact that most of the secret profit
cases would be subsumed under it.
Finally, at its broadest, corporate assets may include all claims
a company has against its directors. If corporate opportunities
which may never mature or secret information belong to the
company in this sense, we are evidently not dealing with an accountant's concept of assets. Any liability of a director to his company
as a result of a breach may therefore be a company asset, and
any ratification of the breach an expropriation of such assets. If
a director is found to owe $10,000 to the company under a section
99 action for breach of his duty of care and skill, is a subsequent
ratification anything other than a mere present to him of that
amount?
107
The class of corporate assets may thus be almost as broad or
as narrow as one wishes. At its most narrow, under the "equitable
property" doctrine, many cases of fraud would seem ratifiable.
At the other extreme, no breach of any sort may be ratified. Like
Price's Exchequer Reports, it may be said of the doctrine that if
one looks hard enough one may find whatever one wants.0 8
Moreover, the doctrine of corporate assets, however expressed,
is arbitrary. A determination of whether a director may in fairness
be allowed to retain a profit made in dealings with the company
must depend upon more than a study of the definition of property
in company or trust law. The doctrine should therefore be abandoned
in favour of a rule more in keeping with contemporary ideas of
commercial fairness.
105 C.C.H. Fed.Sec.L.Rep. 91,288 (1963); cf. Jones v. H. F. Ahmanson & Co.
1 Cal.2d 93, 460 P.2d 464 (1969, Calif.S.C.). Further, in what sense is "[tihe
right to issue new capital ... an advantage which belongs to the company"
so that an improper exercise of the power by the directors can be restrained
in a derivative action under Cook v. Deeks? See Ngurli Ltd v. McCann (1953)
90 C.L.R. 425, 447-48 per curiam and Martin v. Gibson (1907) 15 O.L.R. 623.
106 [1967] 2 A.C. 46.
107 C. Groel v. United Electric Co, 61 A. 1061 (1905, N.J.. Ch.); Helvering v.
Davis 301 U.S. 619 (1937); Keenan v. Eshleman 194 A. 40 (1937, Del.Ch.); aff'd
2 A.2d 904 (1938, DeI.S.C.); the dissent of Cohen J. in Smith v. Brown-Borhek
Co. 200 A.2d 398 (1964, Pa.S.C.) and Comment (1936) 45 Yale L.J. 649, 665. One
may of course argue that a director's liability in such a case is not a corporate
asset
because it may be ratified.
108 Ashton, As I Went on my Way (1924), 27.
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RATIFICATION AND THE DERIVATIVE ACTION
2. Lack of good faith
Where directors are given any powers in a company, "[t]hey
must exercise their discretion bona fide in what they consider not what a court may consider - is in the interests of the company,
and not for any collateral purpose". 10 9 While examples of directors'
fraud abound in the reports, it is sometimes difficult to distinguish
the general duty of good faith from the expropriation of corporate
assets. The distinction is perhaps best made in cases where an
outside company or dissident shareholders attempt to take over
a company. The directors and officers of the target company, whose
future employment with that company may well depend on their
retention of control, will be strongly tempted to adopt defensive
tactics, the most common being a new issue of shares to the
directors or their allies."" In most of these "proper purposes"
cases, company rights were enforced by dissenting shareholders in
derivative actions."' It would therefore seem that such breaches
may not be ratified.
This exception to the possibility of ratification is, however, very
much a child of la doctrine. Thus Professor Wedderburn asserts that
"[t]here can be no doubt that acts which are mala fide, in the
sense that the directors have primarily consulted interests other
than those of the company, are open to challenge by the minority
on grounds of 'fraud' ,,.112 But many of the cases cited in support
of the rule are less than wholly persuasive. Some, for example,
also involve an expropriation of corporate assets." 3 Others allowing
'09InRe Smith & Fawcett Ltd [1942] Ch. 304, 306 per Lord Greene M.R. (C.A.).
On the definition of "bona fide in the interests of the company", see
Greenhalgh v. Arderne Cinemas Ltd [1951] Ch. 286 (C.A.).
110 Cf. cases cited infra, note 102. For a good discussion of this and other
manoeuvres, see E. C. Schmults and E. J.Kelly, Cash Take-over Bids
-
Defense Tactics (1967) 23 Bus. Law. 115. See also Cannon v. Trash (1875) L.R.
20 Eq. 669 (setting the date of a general meeting at such a time as to prevent
some shareholders from voting); Legion Oils Ltd v. Barron (1956) 2 D.L.R.
(2d) 505 (Alta S.C.) (increasing the number of directors to retain control of
the board); Galloway v. Halle Concerts Society [1915] 2 Ch. 233 (making calls
against only a few dissident shareholders when the vast majority of shareholders have not fully paid for their shares).
" Cannon v. Trask, ibid., and Galloway v. Halle Concerts Society, ibid., and
cases cited infra, note 113.
112K. W. Wedderburn, supra, note 2, 98; see also Note, supra, note 85, 81 and
L.C.B. Gower, supra, note 54, 566-67. But cf. B. H. McPherson, Limits of Fraud
on the Minority (1960) 77 S.A.LJ. 297, and R. W. Parsons, The Director's Duty
of Good Faith (1967) 5 Melb.U.L.R. 395, 423.
113 Atwool v. Merriweather (1867) 5 Eq. 464, n; Menier v. Hooper's Telegraph
Works, supra, note 3; Mason v. Harris (1879) 11 Ch.D. 97 (C.A.); Alexander v.
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(Vol. 22
derivative actions deal with the issuance of new shares to maintain
control of a company. That such a breach might be ratified by a
majority resolution was never made wholly clear until recently," 4
but derivative actions to prevent the directors from usurping
control were always permitted. Since shareholders have derivative
actions for ratifiable breaches, these are true exceptions to the rule
in Foss v. Harbottle. In these cases, the directors appeared quite
willing to use their new voting strength to prevail over their
opponents and even, perhaps, to ratify the breach."' A derivative
action was therefore necessary to ensure that the principle of
majority rule in Foss v. Harbottle would be preserved. Without
such a remedy, "the shareholders holding the smaller amount of
shares [might] control the holders of a very considerable majority"."' Such cases are unique since the breach may determine
the result of the vote of ratification. It is therefore somewhat
uncertain whether or not other male fide breaches may be ratified.
If a general rule that mala fide breaches may not be ratified
is not to be found in the authorities, one may nevertheless feel that
such a rule should exist. It seems particularly iniquitous to allow
a director to escape liability where he has been found to be in
bad faith. Such a rule would seem especially suitable in Canada,
Automatic Telephone Co. [1900] 2 Ch. 56 (C.A.); Cook v. Deeks, supra, note 62;
Trustee of the Property of C.E. Plain Ltd v. Kenley [1931] O.R. 75 (App.Div.);
Millers (Invercargill) Ltd v. Maddams [1938] N.Z.L.R. 490 (C.A.); and Re W.
& M. Roith Ltd [1967] 1 W.L.R. 432. The clearest statement of the rule is
perhaps in Ngurli Ltd v. McCann, supra, note 105. There too, however, it was
thought necessary to rely on the "equitable property" doctrine of Cook v.
Deeks, ibid., 447-48.
114 See Hogg v. Cramphorn and Bamford v. Bamford, supra, note 98.
115 Fraser v. Whalley (1864) 2 H. & M. 10; 71 E.R. 361; Punt v. Symons &
Co. [1903] 2 Ch. 506; Piercy v. S. Mills & Co. [1920] 1 Ch. 77; Madden v. Dimond
(1906) 12 B.C.R. 80; Glace Bay Printing Co. v. Harrington(1910) 45 N.S.R. 268;
Bonisteel v. Collis Leather Co. (1919) 45 O.L.R. 195; Smith v. Hanson Tire &
Supply Co. [1927] 3 D.L.R. 786 (Sask.C.A.); Spooner v. Spooner Oils Ltd [1936]
2 D.L.R. 634 (Alta S.C. A.D.); Caufield v. Sunland Biscuit Co. [1941] 4 D.L.R.
714 (Alta S.C.); Hogg v. Cramphorn Ltd, supra, note 98. In the last two cases,
the directors proposed to vote the new shares in ratification of the breach.
Where the minority shareholders have enough shares to prevent the majority
from enacting fundamental changes, and shares are issued to give the controlling shareholders the necessary super-majority, the minority shareholders
may require that the new offer be prorated even in the absence of express
pre-emption rights in the articles. Ratification of the breach by a majority is
not allowed; Martin v. Gibson, supra, note 105.
116 Punt v. Symons & Co., ibid., 515 per Byrne J.
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RATIFICATION AND THE DERIVATIVE ACTION
whose courts do not appear to follow the objective English test
of the proper purposes doctrine." 7
TWO ANOMALOUS CASES
1. Directors' remuneration
Directors and officers may be rewarded in any number of ways:
they may be paid a salary as ordinary company employees; they
may receive long term low-interest loans; 1' they may be offered
lucrative stock options; they may participate in a profit-sharing
plan; or they may be provided with a pension or similar retirement
benefits. But directors have no right to any remuneration unless
authorized by a statute or the articles of the company," 9 nor in
general can they argue that they are entitled to be paid on a
20
quantum meruit basis.1
Since directors are frequently officers of their company, the
compensation of officers usually also involves a conflict of interests.
The possibilities of overreaching are therefore such that some
form of judicial review of executive rewards is essential. But how
are substantive criteria of fairness to be formulated? Comparisons
are not always odious at law, but they are of little worth here if a
standard of reasonable compensation cannot be found:
If comparisons are to be made, with whose compensation are they to be
made - executives? Those connected with the motion picture industry...
Justices of the Supreme Court of the United States? The President of the
United States? 121
1171For the English test, see Hogg v. Cramphorn Ltd, supra, note 98 and
Bamford v. Bamford, supra, note 98. These cases were distinguished by the
British Columbia Supreme Court in Teck Corp. v. Millar (1972) 33 D.L.R.(3d)
288. Cf. also Northern & Central Gas Corp. v. Hillcrest Collieries Ltd (1975)
59 D.L.R.(3d) 533, 598-99 (Alta S.C.).
118 Now substantially regulated by the Business Corporations Act, supra,
note 4, ss.17, 146 and 178.
119 In Re George Newman & Co. [1895] 1 Ch. 674, 686 per Lindley L.J. See
also Northern Trust Co. v. Butchart (1917) 35 D.L.R. 169 (Man. K.B.).
120 Hutton v. West Cork Ry. Co., supra, note 60; Cook v. Hinds (1918) 42 O.L.R.
273, 304-305 per Rose I. (App.Div.); and D'Amore v. McDonald (1973) 33 D.L.R.
(3d) 543, 561 per AddyJ. (Ont. H.C.), aff'd [1974] 1 O.R.(2d) 370 (C.A.). F. W.
Wegenast, however, argued that where the director has served the company in
another capacity, for example, as a manager, he may .recover on a
quantum meruit; supra, note 66, 420. Cf. Brown v. Gentleman [1971] S.C.R.
501, 517 per SpenceJ.
121 Heller v. Boylan 29 N.Y.S.2d 653, 679 (1941) per Collins J.; aff'd 32 N.Y.S.
2d 131. But cf. Beard v. Elster 39 Del. Ch. 153, 160 A.2d 731 (1960); on remand
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The difficulty in establishing an objective standard of compensation
is that typically no market exists to mimic." Compensation schemes
vary so greatly that a consideration of other remuneration plans
will be useful in only the most extreme cases. Further, if some
quid pro quo is relevant, how can one measure the benefit a
company receives from a loyal staff of competent managers? A
final problem is created by differing concepts of the corporation.
If it is seen as a group of capitalists hiring managers, then it follows
that the managers should merely receive wages, with any large
profits accruing to the shareholder-capitalist. But if it is really
the entrepreneurs who hire capital, why should they not participate
in large gains in profits? 123 As a result of such difficulties, courts
frequently find themselves "ill-equipped to solve or even to grapple
with these entangled economic problems". 2 4
In the absence of a clear substantive criterion of fairness, the
legislators and courts have developed procedural requirements for
directors' fees. Thus the Business CorporationsAct provides that a
director's remuneration must be authorized by a by-law passed
by the board. The by-law must in turn be submitted at a general
meeting to the shareholders, who may confirm, reject or amend it. 12
However, in those exceptional cases where a payment can be shown
to be unreasonable, it may be ultra vires the company or a fraud
on the minority.
39 Del.Ch. 476, 167 A.2d 231 (stock option plan); and Saxe v. Brady 40 Del.Ch.
474, 184 A.2d 602 (1962) (management contract with mutual fund).
122Even the economists have failed to provide a scientific model of
reasonable compensation. See J. C. Baker, A 'Just Gauge' for Executive Compensation (1943) 22 Harv.Bus.Rev. 75; R. B. Mautz and G. W. Rock, The Wages
of Management (1958) 11 U.Fla.L.Rev. 474; and A. Patton, What is an Executive
Worth? (1961) 39 Harv.Bus.Rev. (2d issue) 65. See generally G. T. Washington
and V. H. Rothschild, Compensating the CorporateExecutive 3d ed. (1962).
123 See A. A. Berle and G. C. Means, supra, note 31, 342-44. As a further
problem, consider the "right" of workers to participate in the profits of a
company. If it can be shown that the efforts of the President of Generfal
Motors have contributed 10,000 times more to the increased prosperity of the
company than those of an ordinary machinist, should their salaries reflect this
difference? See W. L. Cary, Cases and Materials on Corporations 4th ed.
(1969), 612-13.
124 Heller v. Boylan, supra, note 121, 680 per Collins J.
125 Supra, note 4, s.21. On the right to remuneration without complying with
the analogous requirements of the Corporations Act, R.S.O. 1970, c.89, ss.69
and 70, see D'Amore v. McDonald, supra, note 120, and F. W. Wegenast, supra,
note 66, 401.
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RATIFICATION AND THE DERIVATIVE ACTION
It is beyond the powers of a company to make presents to the
directors which are not related to the affairs of the company. 126
The fee must be "within the ordinary scope of the company's
business" or "reasonably incidental" to it.127 Thus a pension to the
widow of the managing director of a company negotiated after
his death was held ultra vires;128 so too was a widow's pension
made before a director's death, where his health was not good, his
loyalty was already guaranteed by his ownership of company
stock and the agreement gave every appearance of being a mere
sham. 29 Payments made after the company has effectively ceased
to operate have also been held to be beyond the company's powers. 30
"The law does not say that there are to be no cakes and ale but
that there are to be no cakes and ale except such as are required
for the benefit of the company." 131
Excessive salaries and gratuities to directors would seem as
well to be obvious examples of the expropriation of corporate
assets. Where the fee amounts to a mere gratuity, ratification is
clearly impossible. 32 But it is otherwise where the company receives
a reasonable benefit from the transaction:
The company is in such a case obtaining the services for which it is
paying, thus getting a quid pro quo, and there is, I think no foundation
for the suggestion that in such a case there is an appropriation of property.'3
There are few cases where, some services having been provided,
such consideration has been found inadequate. One such case was
Brown v. Can-Erin Mines Ltd, where a management
contract
awarded the majority shareholders of a company $60,000 a year
"for carrying out services which a geologist and an accounting
' 26 1n Re George Newman & Co., supra, note 119. This prohibition is not
affected by the general grant of power in the Business CorporationsAct, supra,
note 4, s.15(2): ibid., 686. It may be, however, that shareholder actions in such
cases must comply with the provisions of s.16; see supra, note 75.
127 Henderson v. Bank of Australasia (1888) 40 Ch.D. 170, 180 per NorthJ.;
adopted in McAlpine v. Fleming (1910) 15 O.W.R. 479, 492 per LatchfordJ.
Cf. Hutton v. West Cork Ry. Co., supra, note 60, 671 per Bowen L.J.
2
1 8 In Re Lee, Behrens & Co. [1932] 2 Ch. 46, 52-3 per Eve J.
9
12 Re W. & M. Roith Ltd, supra, note 113.
13
oHutton v. West Cork Ry. Co., supra, note 60, 677; Cook v. Hinds, supra,
note 120, 307 et seq., per Rose J.
'31 Hutton v. West Cork Ry. Co., ibid., 673 per Bowen L.J.
132 Lumbers v. Fretz [1928] 4 D.L.R. 269 (Ont. S.C.); D'Amore v. McDonald,
supra, note 120.
133 Foster v. Foster [1916] 1 Ch. 532, 549 per Peterson I.
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staff could carry out ...
(Vol. 22
3
for a small fraction of that amount"."'
However, a more typical example of fraud on the minority occurs
where the remuneration is grossly inflated and the services are
almost nonexistent. 35 It has been said that no mere hardship to
the shareholders will suffice. 3 6 The transaction must itself be improvident or oppressive, although the court may consider the
financial position of the company as well as the director's services.'"
13
Anything that resembles a bona fide agreement is likely ratifiable. The onus 'of proof that the company has received an adequate
benefit from their services is on the directors.'3 9 They may also
have to prove that the transaction was bona fide,1 0 although it is
not quite clear what good faith means in this context.1 4 ' It is difficult
to see how an agreement supported by adequate consideration can
be said to be male fide. Bad faith may, however, indicate that the
agreement is a sham, and that the necessary quid pro quo was
42
therefore lacking.1
Substantive limitations on executive remuneration, based upon
the ultra vires rule or upon fraud on the minority, are therefore
quite lax. Because of the great difficulty in articulating a rule of
(1960) 25 D.L.R.(2d) 250, 255-56 per Spence3. (Ont. H.C.).
135 Cook v. Hinds, supra, note 120; Barry v. Laroque (1934) 72 C.S. 70; Nolan
v. Parsons [1942] 3 D.L.R. 190 (Ont. C.A.).
13N Houston v. Victoria Machinery Depot Ltd [1924] 2 D.L.R. 657, 659 per
Murphy J. (B.C. S.C.).
13 Compare Houston v. Victoria Machinery Depot Ltd, ibid., and Cook v.
Hinds,
supra, note 120.
138 Hampson v. Price's Patent Candle Co. (1876) 24 W.R. 754; Parker and
Cooper, Ltd v. Reading [1926] 1 Ch. 975; Allish v. Allied Engineering of B.C.
Ltd (1957) 9 D.L.R.(2d) 689 (B.C. C.A.).
One of the thorniest questions in this area of the law is whether directors
may be remunerated for past consideration. Compare Hutton v. West Cork
Ry. Co., supra, note 60 per Bowen and BaggallayL.JJ. and Bartram v. Birtwhistle (1908) 15 O.L.R. 634 with Fuller v. Bruce [1935] 3 D.L.R. 256 (N.S. S.C.).
Re Dorenwends Ltd [1924] 3 D.L.R. 118 (Ont. S.C. A.D.) allowed a payment
134
for past services which had been ratified by all the shareholders. However,
it was suggested that ratification by a mere majority would not suffice: ibid.,
120 per OrdeJ.A. In light of these decisions, directors are best advised to
draft their compensation schemes as contingent on future services.
139 Parke v. Daily News Ltd [1961] 1 W.L.R. 493; sed qu. Houston v. Victoria
Machinery
Depot Ltd, supra, note 136.
140 1n Re Lee, Behrens & Co., supra, note 128, 51 per Eve J.;fll'd in Parke v.
Daily News Ltd, ibid.
141 See the comments of Bowen L.J. in Hutton v. West Cork Ry. Co., supra,
note
60.
142 Re W. & M. Roith Ltd, supra, note 113; Millers (Invercargill) Ltd v.
Maddams, supra, note 113.
1976]
RATIFICATION AND THE DERIVATIVE ACTION
fairness on this question, one must expect that substantive barriers
will remain weak. There would seem to be little that a legislator
can do to curb overreaching directors in the absence of an economic
model of what constitutes reasonable compensation for their services.
Perhaps the best deterrent in all but extreme cases is the market
for corporate acquisitions.
2.
Contracts with the company
Any contract between a director and his company is voidable
at the instance of the company under the general equitable principle
of Keech v. Sandford.143 "So strictly is this principle adhered to
that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into." '44 This strict rule of equity
is another example of a judicial reluctance to confront squarely
questions of fairness. "It obviously is, or may be, impossible to
demonstrate how far in any particular case the terms of such a
contract have been the best for the cestui que trust." 145 Nevertheless, Ontario courts may in future be required to consider the
fairness of such contracts under section 134 of the Business Corporations Act. The section provides that directors who have acted
honestly and in good faith are not liable for profits made in
contracts with their company if material conflicts of interests are
disclosed and the contracts are ratified by disinterested directors
or a two-thirds vote of shareholders. 4 But in either case it must be
shown that the contract was in the best interests of the corporation
147
at the time it was entered into.
It may, however, be possible for a director to retain all profits
through shareholder ratification without complying with the requirements of section 134. The authors of the Proposals for a New
143 Supra, note 88.
144 Aberdeen Rail. Co. v. Blaikie Brothers [1843-60] All E.R. Rep. 249, 252
per Lord Cranworth L.C. The contract is also invalid if the director's interest
is merely indirect, as where his company deals with a firm of which he is a
partner: ibid.; or a company of which he is a director or a shareholder:
Transvaal Lands Co. v. New Belgium (Transvaal)Land and Development Co.
[1914] 2 Ch. 488 (C.A.). But cf. Kaye v. Croydon Tramways Co. [1898] 1 Ch. 358
(C.A.); in somewhat similar circumstances, the United States Second Circuit
Court of Appeal came to an opposite conclusion: Rosenfeld v. Black 445 F.2d
1337 (1971).
145 Aberdeen Rail. Co. v. Blaikie Brothers, ibid., 252 per Lord Cranworth L.C.
146 Supra, note 4, as am. by S.O. 1972, c.138, s.36.
147 S.115(7) of the Canada Business Corporations Act, supra, note 5 requires
instead that the contract be "reasonable and fair to the corporation at the
time it was approved".
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Business Corporations Law for Canada were confident that in the
absence of statutory disclosure or ratification by a special majority,
the director "has no immunity from the harsh common law rules
which render the contract void". 1 48 But the rule at law was that
such contracts were not void but voidable and capable of ratification
by a simple majority. 149 It seems unlikely that the statutory rules
have changed this, except insofar as they require ratification by
two-thirds of the votes of the shareholders; this is quite obviously
an example of the special majority exception to Foss v. Harbottle.
But there is little to suggest that special fiduciary duties attach
because of this, or that a director may not vote as a self-interested
shareholder to ratify a contract which is not in the best interests
of his company. Such contracts may then be ratified by a special
majority unless it can be shown that they constitute an expropriation of corporate assets or, perhaps, that they are in bad faith.
An explicit statutory prohibition of ratification except under section
134 is therefore necessary to prevent an avoidance of its requirements.
RATIFICATION AND SECTION 99
The above discussion suggests that directors may in too many
cases escape liability through the rule in Foss v. Harbottle. How is
this changed by section 99 of the Business Corporations Act? 1 0
The section does not, of course, affect personal actions by the
shareholders, but only derivative actions under the last two exceptions to the rule. It may not even affect those, except to make
proceedings more cumbersome and expensive if the courts adhere
to the futility principle of Foss v. Harbottle. Assuming that ratification is still possible, some judges may be inclined to agree with
Mullock J. that "it would be purposeless for the Court to entertain
an action" where ratification is possible and the directors "might
in substance repeat their former action".' 5 ' But it was surely not
the intent of the legislators to make it more difficult to bring
derivative actions. Moreover, a subsequent ratification does little
148R.W.V. Dickerson, Proposals for a New Business Corporations Law for
Canada (1971), vol.1, 80, s.233 (hereinafter called The Dickerson Report).
149 North-West TransportationCo. v. Beatty, supra, note 39. See also HelyHutchinson v. Brayhead Ltd [1968] 1 Q.B. 549 (CA.), a case of some interest
since The Dickerson Report took s.199 of the Companies Act, 1948, 11-12 Geo.VI,
c.38 0"as a point of departure" in drafting para.9.17: ibid., 79.
15 Supra, note 4.
151 Kelly v. Electrical Construction Co. (1907) 16 O.L.R. 232, 234.
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RATIFICATION AND THE DERIVATIVE ACTION
injury to the dignity of the court. The basis of the futility principle
is essentially economic. The costs of litigation for both courts and
companies are such that derivative actions should be refused if it
can be shown that breaches are invariably ratified. Against this
must be weighed any external benefits- derived from the sharpening
of issues by the court and the possibility that the breach will not
be ratified. While the bulk of the evidence indicates that directors
may easily obtain the ratification of their breaches ,152 it is not
so clear that they will always want to flex their corporate muscles
in this way. The directors may decide for sound business reasons
not to ratify, for example, where a takeover bid seems in the
offing. Publicizing directors' breaches is highly impolitic where
shareholder loyalty is important. It is therefore not clear that
derivative actions should always be refused because a breach may
be ratified, although the empirical evidence in favour of the futility
3
principle would in most cases seem compelling.'1
It may perhaps be argued that by permitting derivative actions
in section 99, the legislature has implicitly forbidden ratification.
Such an interpretation does not, however, appear to be warranted
by the language of the section. Thus section 235 of the Canada
Business Corporations Act explicitly provides that shareholder ratification shall not be a bar to a derivative suit under the Act.
A similar amendment to section 99 would seem essential if the
interests of minority shareholders in Ontario companies are to be
adequately protected.
Such an amendment would still leave open the question of
when a derivative action may be brought. A great deal of discretion
will then be placed on judges who hear such actions. They will
first be required to determine whether, in spite of clear evidence
1
of a breach, the suit should be refused for business reasons. 4
This may frequently be -beyond the competence of a judge, who
may have to rely on a strict, prophylactic rule, without reference
See supra, note 31.
If directors' breaches may still be ratified, courts should also be
hesitant to order a ratification by shareholders. In most cases, this will be a
meaningless and expensive gesture. Moreover, in those few cases where the
directors may prefer not to ratify, the shareholders will be better off without
such an order. The court may also find itself intruding rather clumsily in a
takeover attempt.
154 See R.N. Leavell, supra, note 14. The judges' discretion is emphasized by
the prohibition of security for expenses in s.99(3); cf. Kaufman v. Wolfson
136 F.Supp. 939 (1955, S.D. N.Y.). But cf. also D. J. Dykstra, The Revival
of the Derivative Suit (1967) 116 U.Pa.L.Rev. 74, 93.
162
153
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to what is fair. However, insofar as it is possible, he should attempt
to evolve criteria of fairness.
One touchstone which as been suggested is ratification itself. In
the United States, where derivative actions may be brought under
similar legislative rules, shareholder ratification has been held to
constitute evidence of fairness.' 55 The authors of The Dickerson Report would also have the courts look to ratification:
If, for example, the alleged misconduct was ratified by majority shareholders who were also the directors whose conduct is attacked, evidence
of shareholder ratification would carry little or no weight. If, however,
the alleged misconduct was ratified by a majority of disinterested shareholders after full disclosure of the facts, that evidence would carry much
more weight... .156
While the repeal of the rule in North-West Transportation Co. v.
Beatty 157 is long overdue, any reliance upon "disinterested shareholders after full disclosure of the facts" would generally be misplaced. "The incompetency of the shareholder of a widely-held corporation, even if he takes an active interest, to deal with the problem
of proposed action against directors is beyond debate." I'l By contrast, a judge considering a breach will usually be in a far better
position to examine the unfairness of directors' acts. The decision
of a disinterested board of directors may, however, be of some weight
in the threshold problem of whether to compromise or abandon the
claim because of possible injury to the good name of the company.
155 Alcott v. Hyman 208 A.2d 501 (1965, Del.S.C.). Comparisons between United
States and Canadian rules on ratification are difficult. Firstly, some American
courts make a distinction between ratification and a decision by shareholders not to sue: S. Solomont & Sons Trust v. New England Theatrd
Operating Corp., supra, note 14, discussed in a Note (1950) 64 Harv.L.Rev. 334.
It is also unclear to what extent American decisions follow the rule in NorthWest TransportationCo. v. Beatty, supra, note 39. Several cases have held that
an interested director may vote as a shareholder to ratify a contract which
appears fair: Gamble v. Queens County Water Co. 123 N.Y. 91; 25 N.E. 201
(1890); Bjorngaardv. Goodhue County Bank 49 Minn. 483; 52 N.W. 48 (1892).
However, most cases involving a director's fraud which permit ratification
insist on a vote of disinterested shareholders; e.g., Claman v. Robertson, supra,
note 14. According to W.L. Cary, supra, note 123, 592 even a ratification -by
disinterested shareholders will not validate a fraud in most jurisdictions. Cf.
Mayer v. Adams 141 A.2d 458 (1958, Del.S.C.) and Continental Securities Co.
v. Belmont 99 N.E. 138 (1912, N.Y. C.A.). Cf. generally R. N. Leavell, supra, note
14; Note (1940) 53 Harv.L.Rev. 1368; A. T. Stickells, Derivative Suits - The
Requirement of Demand upon the Stockholders (1953) 33 B.U.L.Rev. 435; and
Landstrom, Ratification by Majority Stockholders - A Problem in Corporate
Democracy
(1951) 31 B.U.L.Rev. 165.
156 Supra, note 148, 164, sA87.
16 7
Supra, note 39.
15s R. N. Leavell, supra, note 14, 355.
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RATIFICATION AND THE DERIVATIVE ACTION
It may be useful to distinguish the nature of the breaches. Thus
one may wish to allow directors to ratify acts of negligence,. where,
unlike most cases of fraud, they do not personally profit.159 An
analogous situation arises where directors make a profit without
causing a loss to the company. In such cases, of which Regal
(Hastings)Ltd v. Gulliver 160 is a prominent example, it may not be
unfair to allow the director to retain the profit.'-'
The Regal decision provides an example of another difficulty
in evolving criteria of fairness. Derivative actions are brought on
behalf of a company and, if damages are awarded, they are paid
to it and not to the shareholders. However, the shareholders will
normally receive an indirect benefit, and one who purchases shares
after the breach may receive a windfall from the action, 1 2 while
the prior owner is left without a remedy. This problem is particularly
obvious where, as in Regal, new shireholders control the company
and can in effect expropriate the benefit of the judgment.
Another possible consideration is the nature of the corporation.
I have already suggested that ratification by shareholders, in a
close corporation is better evidence of fairness than ratification
in a public company. But here too the question of fairness may
at times be better left to a judge. In a small corporation -the
possibilities of backscratching are such that even the vote of a
"disinterested" majority in ratification may be suspect. While
presumably better-informed than his counterpart in A.T. & T., a
shareholder in a private company may be less concerned with
fairness than with freezing out another member. In addition,
members of a close corporation who decide that its directors are
rogues or fools may not be able to sell their shares. Shareholders
in a widely-held corporation who despair of fair treatment may
at least sell out, even if at a lower price than they might wish.
The criteria of fairness for examining a director's acts are
extremely vague. So, however, are any provisions which attempt
Cf. Smith v. Brown-Borhek Co., supra, note 107.
'10 Supra, note 87.
101 Cf. CanadianAero Service Ltd v. O'Malley, supra,note 3, 608 per Laskin J.
162 Although he may not bring a derivative action himself under the Ontario
Business Corporations Act, supra, note 4, because of the contemporaneous
ownership provision in s.99(3)(a). However, if he is in control of the
company, he may have the action brought by it as the new shareholders did
in Regal (Hastings) Ltd v. Gulliver, supra, note 87. American courts are
more willing to look through the corporate veil in these cases, at least
where no shareholder may bring a derivative action: Home Fire Insurance
Co. v. Barber 93 N.W. 1024 (1903, Neb.S.C.); Capitol Wine & Spirit Corp. v.
Pokrass 98 N.Y.S.2d 291 (1950); aff'd 302 N.Y. 734.
159
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to do equity between the parties whenever possible. In the tension
between prophylactic rules and the broader claims of fairness, an
argument often raised in favour of rigid principles is that the
matter is so complicated that it is impossible for a court to determine
the guilt or innocence of directors. The amount of a director's
salary is frequently of such a character.0 3 In most cases, however,
questions of fairness are not institutionally insoluble, but merely
difficult. On the other hand, prophylactic rules are, if not always
fair, at least superficially inexpensive. They avoid the high transaction
costs of lengthy trials. But in the end they may involve higher
costs to society than rules of fairness. A shareholder hopes to be
treated fairly by the management of his company; he does not
expect windfalls of the sort received in Regal (Hastings) Ltd v.
Gulliver."" Moreover, strict rules may discourage managers from
investing money and labour in their company. General criteria
See supra, "Directors' remuneration" at 191.
164 Supra, note 87. I am assuming the continuing demand for outside
capital and the consequent need for managers to interest investors in their
companies: cf. J. Lintner, "The Financing of Corporations" in E. S. Mason
(ed.), supra, note 32, 166. H. G. Manne has argued that Lintner's findings
demonstrate that "there can probably be no substantial danger to the shareholders of large corporations"; The "Higher Criticism" of the Modern Corporation, supra, note 32, 402. However, takeovers usually involve high transaction costs: the controlling shareholders may require a premium for their
shares if they decide to accept the offer; if not, the offerees may have to comply
with the onerous provisions for disclosure and proration in The Securities
Act, R.S.O. 1970, c.426, ss.81-100. Some further protection to shareholders
would therefore seem necessary. Thus, even before the Williams Bill, 15
U.S.C. ss.78m(d)-(f), Manne himself recognized the need for derivative
actions: Our Two Corporation Systems: Law and Economics (1967) 53 Va.
L.Rev. 259, 272.
A second problem arises from lingering doubts about the competence
of judges to decide difficult questions of fairness and loyalty of directors.
One response to this has been vague suggestions of a "second chamber" to sit
in judgment over the directors: B. Manning, Book Review, supra, note 32
and E. V. Rostow, "To Whom and for what Ends is Corporate Management
Responsible?" in E. S. Mason (ed.), supra, note 32, 46. It is not clear, however,
how such a body could be more independent of the managers of a modern
corporation than its directors. If it cannot, there would seem little reason for
its creation. It has therefore been suggested that independent administrative
boards might supplement or replace the courts in some matters. In England,
for example, the Board of Trade has been given broad powers to investigate
a company's affairs: R. D. Fraser, Administrative Powers of Investigation into
Companies (1971) 34 M.L.R. 260. But the federal courts in the United States
have recently asserted a broad competence over corporate affairs under the
rapidly expanding definition of "fraud" in S.E.C. Rule 10b5. While the ambit of
the rule has given rise to much discussion, the commentators have not suggested that the courts should be replaced by administrative tribunals.
103
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RATIFICATION AND THE DERIVATIVE ACTION
be economically more efficient than
of fairness may therefore
1 5
prophylactic rules.
The decision of the Supreme Court in Canadian Aero Service
Ltd v. O'Malley suggests that Canadian courts will now be more
willing to consider "general standards" of "loyalty" and "good
faith"'0 6 to the exclusion of "rigid measure[s]" and "literal terms". 1 7
Chief Justice Laskin rejected the strict tests of liability of Regal
(Hastings) Ltd v. Gulliver, noting that "I need not pause to con-
sider whether on the facts in [that case] the equitable principle was
overzealously applied". 1 8 Similar doubt was cast 119 on the previous
7°
Supreme Court decision in Peso Silver Mines Ltd v. Cropper.
However, one would miss the subtlety of Laskin C.J.'s reasoning
if one thought that these cases were overruled. The difference
between CanadianAero Service Ltd v. O'Malley and the cases which
preceded it is attitudinal. "[T]he particular facts" in a case of
corporate fraud "may determine the shape of the principle of decision without setting fixed limits to it."
'71
Future decisions must
therefore be considered on their merits, without the "strait jacket" 172
of narrow rules. One may consequently expect that the judicial
leitmotif, whether articulated or not, will be increasingly one of
fairness.
Fairness need not, of course, imply laxity. If liability is no
longer to be determined by considering the rigid rules of Peso or
Regal, one must still have regard to "the pervasiveness of a strict
ethic in this area of the law".173 The novelty of Chief Justice Laskin's
10 All, however, depends on the context. It may be that a prophylactic rule
is of use in providing a collateral social good. Thus strict rules against insider
trading may stimulate the disclosure of corporate information to the public;
see Shapiro v. Merrill, Lynch, Pierce, Fenner & Smith Inc. 495 F.2d 228 (1974,
2d C.C.A.). But cf. H. G. Manne, Insider Trading in the Stock Market (1966).
See also H.-K. Wu, An Economist Looks at Section 16 of the Securities
Exchange Act of 1934 (1968) 68 Colum.L.Rev. 260.
166 Supra, note 3, 610.
107 Ibid., 609. See also Goldex Mines Ltd v. Revill, supra, note 17, 224:
"Fairness is the touchstone of equitable justice, and when the test of fairness
is not met, the equitable jurisdiction of the Court can be invoked to prevent
or remedy the injustice which misrepresentation or other dishonesty has
caused. The category of cases in which fiduciary duties and obligations arise
is not a closed one...".
168 Ibid., 608.
169 Ibid., 618-19.
170
[1966] S.C.R. 673.
171 Supra, note 3, 619.
172 Ibid., 619.
173 Ibid., 607.
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approach in CanadianAero Service Ltd v. O'Malley is methodological
and not ethical. The new duty may, in particular cases, prove more
exacting than the old rules. 174
CONCLUSION
The rule in Foss v. Harbottle was based in large part on the
entirely pragmatic concern that derivative actions might be pointless
if director's breaches were ratifiable. That concern is as valid today
as it was in 1843. The rule therefore neatly divided all breaches into
those which were ratifiable and those upon which derivative actions
would lie. Unfortunately, undue reliance was placed on the capacity
of a majority of shareholders to solve internal management problems,
and most breaches were classified as ratifiable. The derivative
action was then limited to the most extreme cases of oppression.
The unfairness of the division was only noted when studies of the
modern corporation revealed the weakness of the shareholders
and the power of management. Company law reform must seek
to redress this imbalance in some effective manner.
The goal of all norms of company law should be to persuade
shareholders of the security of their investments. Some risks are
of course intrinsic to any investment. However, the separation of
ownership and control has created a second level of uncertainty.7 5
Shareholders must not only take the risk, necessarily incidental to
every investment, that the market will not react favourably to
their company; they now take the additional gamble that the
company's managers may be dishonest or incompetent. It is unlikely
that this second risk can be eliminated through "shareholder
democracy". The role of the law should rather be to provide a
mechanism by which shareholder grievances may be brought before
a court, and a determination of liability made upon a standard
of fairness. If the suggested amendment limiting the right of
ratification is made, section 99 may provide such a tool.
174Nor has the dog been thrown entirely out of the manger. "[T]here may
be situations where a profit must be disgorged, although not gained at the
expense of the company, on the ground that a director must not be allowed
to use his position as such to make a profit even if it was not open to the
company": ibid., 609. But the absence of detriment to the company is presumably one of the "many factors" by which the application of the standards
of "loyalty, good faith and avoidance of conflict of duty and self-interest ...
must be tested": ibid., 620.
175 See N. S. Buchanan, The Economics of Corporate Enterprise (1940), 452
et seq.